To put the impact of the current crisis on the Vescore Active Beta portfolio into a broader perspective, we have compared the stamina it proved in former crises, which we have categorized by three main types:
In each of the above-mentioned cases, Vescore Active Beta lost in value, but each time clearly less than both the average of its Morningstar peer group and the global stock market. Its relative outperformance was the strongest with the structural crisis type and the weakest with the event-driven one. These findings do not provide forecasts but some clues that systematic investing has its advantages, especially during phases of high uncertainty when investors’ irrational behavior usually tends to prevail.
A study by Scope, a leading European credit rating agency, compared systematic investment approaches with discretionary ones and revealed the following: The discretionary approach can generate higher alpha especially in inefficient markets, but it fully depends on the portfolio manager’s experience, skills and investment decisions. While the correlation between excess returns delivered by each type of approach was low, the systematic one achieved more stable outperformance ratios thanks to its discipline and a higher degree of portfolio diversification. Overall, this means less performance fluctuations and less drawdowns for systematic approaches according to the Scope study dated 2019.
Vescore Active Beta’s investment approach builds on two proven proprietary models: one for equities and one for bonds. These models continuingly assess the fundamental environment and return potential with a mid-term view, and make the corresponding investment decisions without emotional biases, while ensuring systematic risk control at all times. The portfolio invests primarily in global equities and government bonds with the aim to participate in rising markets and achieve steady value growth in the long term with a balanced risk profile. It systematically adapts its equity ratio and bond duration to the risks and opportunities the prevailing market conditions offer.
In terms of implementation, our top priorities are security, trading flexibility, and cost efficiency. Therefore, we implement our active strategy with liquid futures at lower transaction costs than with direct investments. We invest the collateral, without expecting additional returns, exclusively in short-term bonds with very high credit quality, predominantly AAA ratings, and denominated in euro to minimize currency risks.
The input factors of the equity model use the term spread, TED spread, credit spread, and dividend yield as indicators. These sets of global market data record long-term economic expectations, confidence in companies, systemic risk, and fundamental equity valuation. Based on this data collection, the model calculates the optimal equity allocation on an ongoing basis. Currently, the equity ratio ranges from 0% to 60%, divided equally between the three regions of North America, Europe and Asia/Pacific.
The input factors of the bond model use carry, mean reversion, and momentum as indicators. Using these data sets as a basis, the model indicates the optimal duration allocation, currently within a range between 0 and 10 years, with the bonds weighted according to the signals.
Risk management is an integral part of these investment process steps. Our proprietary risk indicator continuously measures the probability of a future high-risk state, based on market data sets covering market turbulences across different investment classes.
While the models described above assess market conditions on a daily basis, they each require up to four weeks to process the latest economic variables entirely. Since our last call held on 9 April, on the equity side, the economic regime change fully unfolded and the model now focuses on credit spread as the dominating variable of the crisis. Due to the risk management part of the process, which considered the portfolio’s current low target volatility of 5.5%, the equity weight of 31.5% dropped to 26.8%. Given the positive market sentiment for equities, their risk budget increased at the expense of the risk budget for bonds. On their side, the negative views on future bond yields continue to determine portfolio positioning. The duration shortened from 2.3 to 2.1 years, with the majority of holdings in US and German government bonds.
The current crisis temporarily has narrowed the outperformance of Vescore Active Beta versus the average of its Morningstar peer group. However, the portfolio’s annual performance since launch in 2002 remains in line with its long-term return target of cash plus 3%, while both the 3- and 5-year performance numbers stayed in positive territory. We are convinced that rule-based investing can add value, provided the applied models prove as robust throughout various business cycles as our models have done so far. Therefore, we stick to our systematic investment approach and keep the comprehensible and transparent concept of our Vescore Active Beta unchanged.