Mathematical Finance & Financial Data Science Seminar

On the Value of Portfolio Construction

Speaker: Jason MacQueen, Smart Portfolio Strategies (SPS)

Location: Warren Weaver Hall 1302

Date: Tuesday, April 28, 2020, 5:30 p.m.

Synopsis:

Active portfolio management essentially consists of two steps: stock selection and portfolio construction. Many managers spend most of their time on stock selection, and then deal with portfolio construction by following some simple heuristic, such as equal-weighting or capitalisation-weighting. Most ETFs, for example, use one of these methods.

Unfortunately, this is virtually guaranteed to result in inefficient portfolios that make no attempt to trade-off expected return against risk, and which are therefore likely to have significant unintended bets.  The manager's stock selection skill can easily be dominated by the returns to these unintended bets.

In this presentation we use a simple stock selection rule (similar to those used to create some Style ETFs), and test a number of different methods of portfolio construction.  These will include equal-weighting, capitalisation-weighting, attribute-weighting, inverse volatility, risk parity and Markowitz optimisation.

The talk will also present a modified version of standard Markowitz optimisation, which is well-known to be quite problematic in practice.  Smart portfolio optimisaiton identifies the most inefficient holding in an existing portfolio and only allows a limited amount of trading in those stocks; the purpose is to gain a significant improvement in overall efficiency without incurring too many transaction costs.

Each of the strategies is rebalanced quarterly from the end of 2005 to the present.  Since the stock selection is always the same, the differences in performance and turnover are due entirely to the different methods of portfolio construction.  You may be surprised by the results!

Bio – Jason MacQueen

In 1980 Jason MacQueen founded QUANTEC, which was the first firm to develop risk models for equity markets outside the USA, and which ultimately built risk models for all of the developed and most of the emerging markets.

In 1984 QUANTEC launched the first global asset allocation model, including currency hedging overlays and the first use of reverse optimisation for efficient portfolio rebalancing.

Jason also pioneered the development of multi-factor stock selection models in both the U.S.A. and Japan, and the investment track records of his long-term collaborators are exceptional.

In the early 1990s QUANTEC developed the first global risk model, as well as a global stock selection model.

In the late 1990s Jason and his colleagues developed a statistical risk model-based technique for the American Stock Exchange, which enabled them to offer Exchange Traded Funds (ETFs) on Actively-managed Mutual Funds without knowing the underlying holdings.  This technology can also be used to enable pension funds and other asset owners to manage their overall portfolio risks without having full transparency from their external managers.

QUANTEC was sold to Thomsom Financial in February 2001, and after consulting to them for two years, he co-founded R-Squared Risk Management in 2003 to develop Custom Hybrid Risk Models for institutional investors to enable them to manage their portfolios more efficiently.

R-Squared also developed a unique set of XRD equity risk models covering different geographies.  Among other custom risk models, Jason and his colleagues developed the global equity risk model in FactSet's Multy-Asset Class (MAC) product.

In December 2014, R-Squared's business was acquired by Northfield, where Jason became the Director of Research.  His main focus at Northfield was developing a second-generation global equity model for FactSet's MAC product, which included additional style factors, regional sector factors and other enhancements.

Smart Portfolio Strategies (SPS) was founded in April 2015 to provide sophisticated portfolio rebalancing services to fund managers and asset owners.  Active fund managers seek to outperform their benchmarks primarily by having superior stock selection skills, but the value of this skill can easily be lost if the portfolio is not constructed in a way that maximises its effects while minimizing all other influences on the portfolio's performance.

However, these two tasks require very different skill sets, and not all active managers are comfortable using optimisers and risk models to rebalance their portfolios.  SPS rebalances portfolios by focusing on the most inefficient holdings, thereby minimising unnecessary turnover.  SPS also monitors the portfolio's efficiency so that it can be rebalanced whenever appropriate.

Since founding QUANTEC in 1980 Jason has developed the theoretical framework of Markowitz and his successors into a practical set of tools for institutional fund managers.  By his passionate pleas for a disciplined and logically coherent approach to portfolio management, he has acquired an international reputation as speaker, consultant and iconoclast.  He was educated at Oxford and London Universities, where he read Mathematics and Theoretical Physics.

He was the founder and first Chairman of the London Quant Group, a not-for-profit organization established in 2007 to arrange Seminars on the practical application of quantitative investment technology; these seminars are the successor to the QUANTEC Investment Seminars, first started in 1986, and held at Oxford or Cambridge Universities.

He has been an Honorary Lecturer at Lancaster University Management School, and a Visiting Professor at Tokyo University's Center for Advanced Research in Finance.  He is also a Director of the Society of Quantitative Analysts in New York.