The Wonderful World of Equities
Equities are an amazing asset class. Not only have the markets gone up for more than 100 years, but also the way we buy shares of exchange traded companies and what we can do with them is simply mind-boggling. Nowadays, anyone can buy anything, anytime and from anywhere, including by using our so-called smart phones. And the costs have tumbled. Execution costs, custody fees and even trading margins have become commoditised, marginalised and remain under continuing attack from better technology and ever increasing efficiency.
So, let us explore some of the most popular strategies, products and new terminology that all have to do with equities, yet are quite different in the risk and value they pose.
Index Funds – Whereas indices such as the Dow Jones have existed for centuries, being able to buy them as a single product has only existed for a few decades. It seems a world without so-called exchange traded funds (ETFs) is as hard to imagine as a world without email or the internet. Fact is, getting exposure to broad country or sector indices and the many thousands of international companies they hold has never been cheaper, more efficient or offered more value as essential building blocks of any equity allocation.
Active funds – The objective of active management is to add value through either exceptional analysis, insight or clairvoyance. The emerging markets are often cited as requiring more local knowledge of sort and therefore, it is advised to pick (better) stocks over the ones in the index. That may be true, for a while, and maybe it is not. The fees, however, are a lot higher than those of passive index funds (see above). On average, by a factor of three to one. There are also the higher trading and operational costs to consider, as active strategies lack the trillion-dollar scale of the passive industry behemoths such as Blackrock or Vanguard.
Smart Beta – The idea behind these strategies is brilliant: what if we could do active management, but get it at a passive price? And so, the quants and strategists went to work and we now have an amazing array of differently packaged indices that do things like weighting every stock in the S&P 500 equally, rather than according to their market capitalisation. Could work and might even be fun. Yet, I always find, if you want to be smart, you are better off trying your luck looking for alpha. Because that is where you get better reward for the risk you take, if you are truly smart, that is.
Systematic Strategies - These quite rudimentary algorithmic trading strategies look for higher probability trades, based on what has happened in the past. For instance, they will buy more or less of a selection of stocks, based on the level of volatility in the market or some other factor or measure. These strategies will work some of the time and for as long as a historical pattern repeats itself. However, if you are not in the right market environment, they will not. Which kind of takes away the whole point, because if I could predict the right market environment, I wouldn’t need a systematic strategy to make money.
Risk Premia – As disciples of “risk” ourselves, we did take a very long look at strategies that try to extract so-called “risk premiums”, such as value, growth or volatility from a specific selection of stocks. Whereas the concept continues to excite us, we are still not convinced that getting exposure to these premiums through these strategies is any more effective than holding a broad portfolio of stocks. The big question is whether or not increasing our allocations to one over the other will actually add any value, given the difficulties in timing and the rather large potential opportunity costs?
All in all, there is something here for everyone, depending on their belief system and where one thinks one can add value. If you like picking stocks, there is no shortage of research available practically everywhere. If you like expressing themes through smart or highly sophisticated quantitative algorithms, there are thousands of different products and strategies at your disposal. And if you like to do absolutely nothing, then life has never been better than buying passive index funds and letting Father Time do the growth compounding for you.