Applying quantitative screens to thematic robo-advice portfolios can improve results without increasing risk, according to Quantifeed.
The company said there were currently two methods for building indices – thematic, which utilises investment themes, and factoral, which draws on empirical research of past returns – but added that a robo-advisers using a combination of the two are likely to offer better results.
“The thematic and factor approaches to building indices have their own individual advantages for digital wealth management services, however at Quantifeed we believe that through a calculated combination of both, financial institutions can deliver a much better risk-adjusted performance,” said Quantifeed senior quantitative strategist Gaudi Schneider.
These factors can be added to an index in multiple ways, including in the stock selection process, or by applying weights based on the chosen factor.
“For example, low volatility stocks have been shown to outperform higher volatility stocks over extended periods of time,” the company said.
“The enhancement of an existing stock selection with a low volatility factor can be easily achieved by assigning each stock a weight based on its volatility: the lower the volatility, the larger the weight of the stock in the index.”
Quantifeed said this combined approach “produces a more focused and exclusive exposure to the theme”, allowing for a more refined stock selection within the overall theme.
“The quantitative factor does not alter the theme, but brings out a new quality, for example themes that feed on rapidly developing new trends, such as social media, are best integrated with a factor that identifies momentum,” the company said.
“Themes that can play out over a decade, like demographic change, are best integrated with factors like value or low volatility, which avoid speculative positions and instead favour stocks appropriate for the long run.”