Investment Management: Investment Process
Our equity selection process includes three key factors
Equity Selection Process
Value is the most widely recognised and researched quantitative factor in the equity selection process. This model buys stocks that are cheap and sells stocks that are expensive. Cheap stocks are measured by looking at the price of the asset relative to its underlying fundamentals, such as book value per share, earnings per share, cash flow per share or dividend per share. China, like many places in the world, displays alpha generated by value investing. The value factor uses both historical valuations as well as consensus forecasts to determine value and it has historically delivered low but stable alpha over the cycle in the portfolio. It is sector neutral and compares only well established blue-chip stocks.
The next most recognised quantitative factor would be behavioural and sentiment driven factors, such as momentum. Millions of retail investors in China tend to be quite sensitive and may overreact to any information they are given, be it on government policy changes, earnings announcements or any news. The retail market trades without consideration for what has already been priced in. Hence, mean reversion is prevalent on the entire market , with a realisation period between 1-3 months especially on the small/mid cap stocks.
The mean reversion factor buys stocks that have fallen the most but was filtered for warning signs such as suspensions as well as high volume. It provides the highest alpha over the testing period, with the highest turnover.
The Quality factor refers to the process of selecting companies based on their fundamental ratios such as RoE, RoIC, RoA and D/E ratio. High Quality shares tend to trade at higher valuations than low quality shares however , in China this has not been the case. A normalisation to the rest of the world would result in quality shares providing alpha in China for the foreseeable future.
Mixing the factors and risk control
After the stocks are identified, risk control is applied. Each share in our portfolio is limited to 1.5% over and underweight per counter while sector limits are set at 5% maximum over and underweight relative to the index. After both are controlled, a tracking optimisation is done to further identify and minimise risk while maximising our factor exposures. The strength of our process is in diversifying away all company specific risk, while maintaining exposure to the factors we believe will outperform over the long term.